When Thatcher wanted a weaker pound

David Willetts writes in the Financial Times today about the benefits of a strong currency, and cites Margaret Thatcher in support of his argument. In broad terms, he is right: it is better to have a strong currency than a weak one and, as he suggests, Mrs Thatcher tended to see the value of the pound as a national virility symbol.

However, it is even more important to have the value of one’s currency right than to have it strong. This raises the question of how one can know what the right value is, and by way of an answer I refer back to the lady that Willetts cites – Thatcher herself. As some readers will remember, the combined effect of North Sea Oil and the Government’s economic policy pushed up both interest rates and sterling during the early period of her first government. The effect was to squeeze the economy severely.

“On 5 February [John] Hoskyns sent Mrs Thatcher summaries of the work done by the Swiss economist Jurg Niehans to try to answer the question ‘Why is sterling so high?’ ” Charles Moore writes in the first volume of his biography of the former Prime Minister. Niehans’s view was that sterling and interest rates were too high, and that government policy was helping to make them so.

To put a complex story simply, it was in his view pursuing the wrong form of monetary control. “The Treasury, with its MTFS [Medium Term Financial Strategy], had been pursuing the ‘gradualist’ approach advocated by Milton Friedman,” writes Moore. “But the markets’ perception of what was happening had produced a high exchange rate, thus precipitating the crisis advocated as a necessary shock by Friedman von Hayek.”

At this point, a new figure enters Moore’s narrative. “David Willetts, then private secretary to Nigel Lawson, remembered: ‘though we were trying to do Friedman, we were actually doing Hayek’.” What happened next is well-known. Geoffrey Howe’s 1981 budget cut public spending and raised taxes, which allowed interest rates and the exchange rate to fall…thus paving the way for a long period of Thatcherite economic growth.

Admittedly, the situation in the early 1980s was very different from today’s. Then, the economy was on the floor. Now, it is doing too nicely. Then, interest rates were too high. Now, they are too low – at least if you accept Theresa May’s critique of the Bank of England. Furthermore, Thatcher was less preoccupied by getting sterling down than by getting interest rates down.

None the less, the point holds. One’s currency can be too strong, and even Thatcher went through a period where she had to concede this was so. It can be argued that the pound has recently been overvalued, and that its recent devaluation is timely – see Ambrose Evans-Pritchard’s claim that the change is “necessary and desirable”. Either way, Niehans’s intervention had long-term ramifactions. It led to the Government abandoning M3 as a economic signpost, to Nigel Lawson’s disillusion with monetary targets…and thus, eventually, to the ERM.